Question

Shao Airlines is considering the purchase of two alternative planes. Plane A has an expected life of 5 years, will cost $100 million, and will produce net cash flows of $28 million per year. Plane B has a life of 10 years, will cost $132 million, and will produce net cash flows of $27 million per year. Shao plans to serve the route for only 10 years. Inflation in operating costs, airplane costs, and fares are expected to be zero, and the company's cost of capital is 9%. By how much would the value of the company increase if it accepted the better project (plane)? Do not round intermediate calculations. Enter your answer in millions. For example, an answer of $1.234 million should be entered as 1.234, not 1,234,000. Round your answer to three decimal places.

$

What is the equivalent annual annuity for each plane? Do not round intermediate calculations. Enter your answers in millions. For example, an answer of $1.234 million should be entered as 1.234, not 1,234,000. Round your answers to three decimal places.

Plane A: $

Plane B: $

Answer 1

PLANE B SINCE THE VALUE OF THE COMPANY WILL GO UP BY $41.2768 MILLION.

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Plane A (For years 1 - 5):

NPV = -100 + 28 [(1+0.09)^5 - 1] / [0.09 * (1+0.09)^5]

NPV = -100 + 108.91

NPV = 8.91

Plane A (For years 6 - 10):

NPV in terms of value will be same since number of years and cash flow will be same. But that investment will be made at the end of year 5, and cash flows will begin in year 6 and end in year 10. So value of 8.91 will be in future, and made it in present value.

FV = PV (1+r)^n

8.91 = PV (1+0.09)^5

PV = 5.79

Total NPV of the Plane A = 8.91 + 5.79 = 14.70

Plane B

NPV = -132 + 27 [(1+0.09)^10 - 1] / [0.09 * (1+0.09)^10]

NPV = -132 + 173.2768

NPV = 41.2768

Therefore Plane B is better since the value of company will go up by $41.2768 Million.